After a tumultuous year of headlines and a strong showing for major U.S. indexes, 2016 is finally nearing its end.
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On this episode ofIndustry Focus: Consumer Goods, Vincent Shen and Fool.com senior contributor Asit Sharma take some time to reflect by sharing their favorite surprise winners of 2016 in the consumer and retail space, before turning their attention to some important trends and takeaways for 2017.
A full transcript follows the video.
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This podcast was recorded on Dec. 19, 2016.
Vincent Shen:Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day.I'm your host, Vincent Shen.It is Monday, Dec. 19; we'rerecording a day early in the studio this week. Joining me via Skype is none other than Fool.com senior contributor, Asit Sharma. How are you, Asit?
Asit Sharma: I'm well, Vince,thank you very much.
Shen: I have to ask you, what do you havefor your holiday plans?
Sharma: I just want to tell you about my immediate plans. You don't want to hear about the long, drawn-out deluge of business that I have planned. But, after work today,I want to challenge all listeners --I'm going to do this too --let's all hit the gym or take a run and clear out the way to eat, drink, and be merry. It's been a wild year, and I for one want to hit somecomfort food over the holidays.(laughs)So my immediate plans are to work out and pave the way for some good eating over the next couple of weeks.
Shen: Absolutely, I think that's a very good note. The Motley Fool Answers team,they had anawesome episode in November, it was their "Maintain Don't Gain" episode, andthere were some great tips from our chief wellness officer, Sam Whiteside. She talks about some ways to splurge and enjoy the great food thatcomes with the holiday season, but also not allowingthat to start you off on too negative a trend toward the end of the year, andgiving you a strong start to 2017 as well.
But, for our final newepisode of 2016, I did want to spend some time with you, Asit, looking back on the year, and then finishing up with a view of the new year and beyond.
First off,we had some big surprisesin 2016in terms of the U.S. presidential election,Brexit, lots of other events. Overall, the broad market has been able to buck a lot ofexpectations. It's been really happily chugging along, the S&P and Dow have both deliveredapproximately 10%and 14% year-to-date gains,respectively. Recall that things wereactually very rough earlier in the year. By mid-February, both the S&P and Dow were down more than 10%. Atcurrent levels, they have actually managed to jump a solid 25% in thoseensuing 10 months or so.
For our year-end part of our discussion, I wanted to look at a stock that surprised us in 2016. Asit, what was your pick for the consumer retail world for the company that really surprised you in 2016?
Sharma: Vince, a stock thattook me completely by surprise this yearwas none other thanWendy's(NASDAQ: WEN).It's a perennial No. 3, world's third-largest burger chain,always trailing behindMcDonald'sandBurger King, which seem to be more in the conversation. Threw out some amazing numbers. Up 30% year-to-date on a total return basis. What'seven more impressive is going backto Jan. 1 of 2015 -- the stock is up 57% on a year-to-date total return basis over these two years. Not something we usually correlate with the quick-service restaurant industry. Great margins since 2015, [with] the operating margins up over 50%.
Wendy's is doing this in three ways. It's impressing investors by its cost-cutting. It's also remodeling stores at a pretty good clip. You may remember that McDonald's went through a big store refresh a few years ago. Now, it's Wendy's turn. It's also refranchising, that is, selling corporate-owned franchises to individual owners and teams of owners. It'sgoing to a model where it will look more like Burger King,which is 100% franchised. Wendy's, by the end of this year, will have 6,500 locations, and only 5% of those will be corporate-owned.
Shen: Yeah. You touched on a few things.I'll have to say, you mentionedthe perennial third among the big fast food chains. Wendy's is definitely a company that I don't think we've touched on very recently on the consumer retail-focused segment of Industry Focus. That operating margin increase of 51% is really impressive in this space,especially some of the gains that the stock has been able to enjoy. It's definitely not something you typically see from what would generally be considered steadier, more stable names like aMcDonald's, for example. You mentioned some things,like the new store remodeling, which, yeah, that'sdefinitely a trend we saw with McDonald's as well.I think that has been very helpful in terms ofhelping to improve some of their foot traffic and store visits. What else has the company been working on, or have they been able to deliver to help boost the stock and see some of these strong results that they've been able to enjoy?
Sharma: They havea few strategies that they're employing. One is called "buy and flip". Back in the real estate boom, everyone was discussing how flipping homesmight be a good investment. That was before it all crashed.Wendy's take on "buy and flip" is,instead of selling all the restaurants to new people or new franchisees, they'reactually buying some of those back, butthey're not holding on to them. So, Wendy's will buy a franchise unit, or several units, and then sell it to a different franchisee, which isperceived to be stronger, has better operating efficiency, and really knowshow to manage the restaurants well. So,you can think of this as transferring its own restaurantsfrom one franchisee to another. It's called buy and flip.I think it's a really good strategy.
Also,they are focusing on the basics. Manycompanies lose sightof the basics that pull in traffic from day to day. Wendy's is one whichhas quietly always adheredto quality service, speed,accuracy, the types of things that you now hearMcDonald's talking about to regain customers. I think, this fall,Quick-Service Restaurantmagazine, does an annual survey ofall the major fast food restaurants in the U.S. This year, they ranked Wendy's No. 1. It has anaverage drive-thru service time of 169 seconds. It's the fastestdrive-thru service in America. McDonald's comes inat about 208 seconds, and Burger King comes in at about 201 seconds. By focusing on the basics, andcombining that with this larger strategy ofgetting its own units into the hands offranchisees, which reducesits own operating costsand brings in that great royalty and rental income. Theyput together this total picture that'sboosted earnings andenabled the stock to take off. I want to cite one last statistic. Forexample, this last quarter, Wendy's had $49 million in net income. A year ago, they had $7.5 million in net income. So,they are really generatingvery impressive margin gains year to date.
Shen: Thank you, Asit. The drive-thrunumber is really interesting. I think it's reflected, too,in other companies across the restaurant sector in general,when you look at some of the news recently aroundChipotleand howmanagement has talked abouthow they essentially took the eye off the ballin terms of their service. That is a really key component that'svery important. McDonald's has obviously shifted tosimplifying their menu, making sure thatexperience for customers is enjoyable, and helping boost loyalty,as you mentioned, that's so important. So, really interesting to seesomething like your drive-thru experience quantifiedwith that average time.
If we can move on here, in terms of our surprise stocks, for me personally, this one was something that Ipreviously on the show had talked aboutthis company and some of its competitors,we kind of beat up on it at times,and that'sSodaStream International(NASDAQ: SODA). Previously, withKeurig Green Mountain,for example, with SodaStream,these were companies that were the whipping boy for a lot ofpeople following the stock market, in terms of having hit these incredible highs -- for SodaStream, as recently as 2013, when their stock peaked at $70. They were in a position where there were somevery interesting rumors at the time of an incoming buyout from potential industry heavyweights likeCoca-Cola,Pepsi. These were at insane valuations, like $90 to $100 per share. Management was givingshareholders some really strong guidance. They said they hoped to hit revenue of $1 billion by 2016. That was just three years ago, they were talking about this in 2013. But those buyout rumors fizzled out. Growthstarted to decelerateand went into a full-on reversal. The stock went from those $70-plus peaks, andbottomed out at around $13over the next few years.
But, 2016 has been much kinder. It is up 140% year-to-date, having traded up from about $16 per share to its current level at over $38.I think it's really important,with some of that background, when the stock was at its highs, that it's really pivoted its strategy and been able to shift its focus toward what has been a very strong segment within the beverage industry,and that is with sparkling water.First of all, the company is called SodaStream, but it's pretty much, in some ways, abandoning its namesake market and embracing the sparkling water segment. Youlook at the news in 2016about how soda consumption in the United States is down to 30-year lows.I don't know about you, Asit, but I myself drink soda less than ever.I don't know if you've ever been much of a soda drinker. What is your experience with sparkling water? Is that something that you've seen yourself start to take hold in terms of itspopularity? A lot of these other brands like LaCroix, also becoming very popular?
Sharma: Personally,I used to drink a ton of soda,a big fan of Coca-Cola. I just gave up soda about four years ago on a whim,and it just grew, I didn't want to drink it anymore. And I think a lot of us can extrapolate this experience into the numbers for a company like SodaStream. We all want to be healthy.I think SodaStream is a great example of a company which actually was in decline and had a new marketopportunity and took advantage of that.We should probably also mention that its primary competitor, which was going to be theKeurig Green Mountain, as you mentioned, with their Keurig Kold, which was primed to be acompetitor to SodaStream, well that really never panned out. The company was sold off, and that has restored the moat that SodaStream claims. I think that is important as well.
But, you'veisolated what is really the prime advantage for SodaStreameven moving forward. We've seen with a company likeDr Pepper Snapple, we've also seen this withNational Beverage Corporation, sparkling water is a huge wave because its main advantage is it's lower in sugar, and the carbonation is still there. Because SodaStream was already positioned with the carbonated water, it's going to take advantage of this. Like many other people, I had given up on the stock. Speaking of waves, the stock chart of SodaStream over the last year or so looks like a surfer on one of those big Hawaiian waves. It has a great curve going up. It may bea little bit ahead of itself at this point,but again, this goes back to something we talka lot about at The Motley Fool --that is, if a company can establish a competitive moat, you want to be in that stock.I think many of us thought thatadvantage had slipped away,but circumstance and fortune have restored it in that its competitor, the Keurig Kold, is no more.
Shen: I want to add that,overall,bottled water is on the riseas compared to your sugary carbonated beverageslike soda. Sparkling wateris only a really small portion of that market -- the bottled water market -- overall. Last year, it saw incredible growth,I think it was 26% in 2015, which is pretty unheard of when you'relooking at the beverage industry and something like soda, seeing these declines. I mentioned two things. You take that broader beverage segment tailwind, that SodaStream is enjoying with its pivot.
I alsowant to combine it with something that you had mentioned to me previously, Asit, when we weretalking about some of the supertrends we were seeing in the consumer retail sector. We didn't get to do an episode quite yet on this specific topic --the fact that people are becoming more and moreconscious and aware of the varioussocial, health, and environmental impacts behind their buying decisions. We've beentalking a little bit about Keurig Green Mountain. I think there was a huge uproar maybe a year or two ago about the billions of K-Cups that get trashed in single year, how they could circle the Earthsomething like a dozen times over. When people heard that, wereable to visualize that kind of impact, there was definitely a lot of controversy, a lot of consumers basically started to rethinkhow they view that companyand that consumption process.I think the same thing is happening forbottled and sparkling water, to an extent. My wife and I will often go to the store, we'll buy a six-pack or 12-pack of 1 liter bottles each week at the store if we want sparkling water. Andeven though we recycle those bottles,the idea of being able to use one refillable bottle with your SodaStream and one CO2 cartridge, or refillable cartridge with the SodaStream system that can make 130 liters, or 60 liters even, with the water, becomes much more appealing.
The way that has materialized, ultimately, with the product growth of the segment that they're pivoting to, and plus the fact that that eco-friendly benefit that SodaStream, in the past, really marketed on coming back to the forefront. Revenue was down 27% in 2015, down from their 2013 peak. Operating margins were really taking a hit. They shed five percentage points, shrinking from 7.5% to 2.9%.Then, keep in mind that the way theygenerate the revenue betweenthe beverage machine sales,but also thecartridge refills,and also their consumables, like the flavors. Theirmost recent couple quarters have shown acomplete reversal, of course,with some, admittedly, much easier comparisons. Machine sales are up 33% year-over-year for the most recent quarter. That growth isaccelerating. Refills are up 9%. I think the refill growth is important,because that's a good proxy for whether or not these devices that they're selling are being used in the market. Otherwise, management has been focused onreducing expenses,making production more efficient,and that has really allowed them to translate some of these top line gains into their bottom line growth, as well. Net income margin, for example, went from 2% last year to 12% this year. Huge, huge expansion there.
I think, for this company, the recovery seems to be under way. I will personally be watching SodaStream closely in 2017. You mentioned,maybe it's gotten a little far ahead of itself. I would agree with you, generally. But I'm curious to see theirresults from the holiday season,since they have so much momentum going for them now. And,it's a reminder to me that if everyone's beating up on a company, but it has parallels with a strong growing market, it has a well-established brand, and has a pretty sizable network of established users, sometimes it'sgood to look in the other directionthat everyone else seems to be looking,because you can find opportunities like this, withSodaStream up almost 140% year-to-date.
Sharma: Yeah, be a contrarian.I want to make one last quick point about SodaStream,if you're following it in 2017, I really like that the company focuses on the European market. Many growing companies go straight to Asia because the population growth is there, and the wage growth is there. But Europe, a developed economy, and really a prime market for SodaStream's product. They have a higher social consciousness, which you mentioned, and Vince, yeah, we'll tackle a show after the new year on this environmental and sustainably conscious investing. But this is an advantage for them. They know their markets very well, so go ahead and play in that.
Shen: Asit, wrapping up our last new episode of consumer and retailIndustry Focus for 2016,we'll have to look ahead to look at 2017 a little bit. Is there anything in terms of trends, companies,announcements you're expecting,anything you're expecting to see, or anything you'll be watching closely for the new year?
Sharma: Sure. I have two. One is for investors: Be cautious around big-box retailers.I want to read our listeners the last trailing 12-months' revenueof some stores you'll be familiar with,ticker symbols you will know. The first isWal-Mart. Its total revenue increased over the last 12 months, up 0.5%;Nordstromup 1.4%;Macy'sdown 3.5%;Targetdown 4.5%;Amazon.comup 13%.(laughs) There's a simplisticconclusion that we can draw from this -- thatAmazon is taking market share and revenue growth shareaway from the traditional big box retailers. We've been hearing this for years. ButI want to point out that, verypresciently,Starbucks' soon-to-be-retired CEO,Howard Schultz, said two years ago thatwe are going to see a real market transformation in the next --I think he pegged it at one to two years -- that we'regoing to see a decline inphysical store visits for retail stores,we're going to see online retail ramp up. So, while the trend has been there for several years, and we've allparticipated in that by buying more things online, I think 2016 for me was the year where it really became apparent in the growth that online retailing has had in this past year. Looking ahead to 2017, if you're going to buy a big box retailer, if you're going to go out and buy a Macy's or a Nordstrom, or even a Wal-Mart, which hasdiversified into groceries,be careful, and make sureyou have a persuasive reason to buy that stock,and that the management team has a strategy to compete online. Of these,I look at Wal-Mart and I think,that strategy is evolving pretty well, and they've seen some progress with theiracquisition ofJet.com. So, that's one trend that I want investors to join me in looking at in 2017.
Shen: OK. On my end, I think, something I really wanted to touch on really quick,it's a little bit bigger picture,but something to keep in mind for next year, a big theme of the year will beuncertainty. You hear it everyday,you see it in the news everyday,a lot of this uncertainty around, for example, what the first year of President Trump's term will be like. In general, you have things around politics and elections coming up next year withthe rise of populism, for example,and how that might shake things up in the European Union.
But, all in all, I think, having read, in the past couple days, preparing for this show, I read at least a dozen 2017 outlooks from variousfinancial firms likeBlackRockandMorningstarand places likeBusiness Insider,Newsweek, Timemagazine. Some of them get reallyspecific with their predictions. Some financial analysts will even pegwhat they think the S&P will close at specifically for 2017. The consensus that I could find seemed to be at 2,300. But,there's a little bit of futility in all of this. Look for the strong businesses, the ones withquality management that have something like a defendable moat. You really just need to take the Foolish view beyond 2017 and looking to the long-term because of the fact that, when you have all this other noise, it can sometimes make it seem really difficult to pick that right company with the right story with that long-term view. It will seem especially hard when you have some of these outside forces that can push stocks one way or the other because the politics, or because what the president's policies and how they come into play affect things. But, when you're looking out beyond 2017, five, 10, 15 years or longer, it really makes it a lot easier to stomach that, and not have to worry about things like that too much, and thatuncertainty.
But the one thingI will get a little bit more specific foris with labor and wagesand the increasing momentum for higher wages across the country, and how that can,especially in our consumer and retail space, have a big impact on various companies and sectors, in terms of theirexpenses. Think restaurant industry, retailers, and how that plays into things. But, anything else you want to wrap up with, Asit, before we kick off for 2017?
Sharma: Sure,I wanted to go back to your point, Vince, it's awonderful point about uncertainty. If you take thefinancial equivalent of uncertainty,it's probably volatility in the market. We can expect this year to be more volatile than the last. Thatmay or may not pan out, but certainly, from what I've read, this looks like what's in store for us. But thatdoesn't necessarily mean that your stocks will end the year down. It doesn't mean they'll end way up. It simply means, as Vince says, that you should focus on thecompanies that have strong earnings, strong operating cash flow, access to market growth, market demand -- all those basicbuilding blocks of a great investment are more important in anenvironment like this than they might be in other years, when that rising tide is lifting all boats. So, Iabsolutely agree with you there. It's going to be a more volatile year, most likely. Sobuckle down and do your homework. We'll try to help you with some of that in 2017, as always.
Shen: Yep. Call that foundation of thesecompanies and businesses that we look at your constant. There will be a lot of other things happening,the volatility, even quantified with, for example, the VIX volatility index, that has had plenty of ups and downs, hit near five-year highs several times in 2016. But again, broad market up 10% to 14% for the S&P and the Dow. Otherwise, focus on those key components and themes. Otherwise, thank you Asit for a great year. That's a wrap for us in 2016.
Before we go, I want to give a huge thanks to all the Fools out there, old and new, for listening, spending your commutes, your workouts,whatever time you have, tuning in. It's been afantastic year for mestepping into the host seat. I hope you've enjoyed it as much as I have.
Thank you again, and rememberyou can reach out to the entire Industry Focus crew via Twitter @MFIndustryFocus, or send us any questions via email at firstname.lastname@example.org. Go towww.fool.com/podcaststo check out our other awesome shows. Please rate us on iTunesif you have a chance. People on the programmay owncompaniesdiscussed on the show, and The Motley Fool may have formal recommendationsfor or against stocks mentioned,so don't buy or sell anything based solely on what you hear during the program. Thanks for listening and Fool on!
Asit Sharma has no position in any stocks mentioned. Vincent Shen has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com, Chipotle Mexican Grill, PepsiCo, and Starbucks. The Motley Fool owns shares of SodaStream. The Motley Fool recommends Coca-Cola and Nordstrom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.